The purchasing power of your income

The sizing gauge for your property empire, at least at the start. Most people are not aware of their purchasing power, and it could be your superpower to build your property portfolio. Ensuring you nurture and grow your purchasing power initially, will lead to great property riches.  

The general idea of purchasing power is related to the purchasing power of money and how inflation reduces your purchasing power of money over time. Today we will focus on your purchasing power regarding property investing. The banks use this as one of their metrics to assess you, knowing your purchasing power is vital to building your property portfolio.  

What is purchasing power regarding property investing?

Purchasing power regarding property is the maximum amount of money the bank will loan you to invest in property. Once a property is purchased, it will reduce your purchasing power by that amount. If income is derived from the property then some of the income can be added back to your purchasing power. 

Overall, purchasing power is a gauge of how many property loans you can get. All investors start small, hence nurturing and growing your purchasing power by investing in income-generating property will lead to a substantial portfolio in years to come. One way of achieving this is explained in this article where the investor protects their purchasing power and keeps on reinvesting in income-generating properties until freedom is achieved or when they can fund their lifestyle from the income-generating portfolio. For the average investor, maximising your purchasing power to reinvest in income-generating assets is a fast track to wealth, as the use of leverage magnified your wealth. 

How banks use purchasing power 

To understand purchasing power, you need to know about the guideline rule, the 30% rule. The 30% is a guideline where the banks will provide you with a maximum loan, where the monthly repayments are not more than 30% of your gross monthly income. For example, if Person X earns R60 000 pm, the banks will roughly provide R1,8m in loans, which will be roughly R18 000 pm (R60 000 x 30%= R1,8m)

Here is a great bond affordability calculator that shows that roughly 30% of the gross income is the maximum loan, this is overruled only by affordability if your net monthly income minus expenses become less than 30% of your gross income. 

A quick example will give us some insight into how the banks use purchasing power to determine their maximum loan to you. This is not the only criterion that's taken into account but will provide a good background for your knowledge when doing your next property investment. 

Quick example: 

Monthly gross income = R30 000

Monthly net income = R25 000

Expenses = R5 000 

You will notice that even though you can afford a bond of R20 000 pm, the bank will only provide a maximum loan of R900 000 or R9 000 which is 30% of R30 000.

Once you adapt the expenses and it starts to drop below R9 000 pm then the loan amount will become less. Changing the expenses to R20 000 pm, and recalculating, you will notice the loan amount has dropped to R500 000 or R5 000 pm.

How to improve your purchasing power 

Now that we have some insights into purchasing power, we can work out how we can improve this. To improve your purchasing power you can increase your income or sell a property to release the old purchasing power. When building a property portfolio, you want to keep the better income-generating properties and sell the worst-performing ones, this way you ensure your purchasing power is put to maximum use. By earning income from rental properties, the bank includes roughly 80% of rental income to your income when calculating affordability, which will further increase your purchasing power. 

The opposite applies too, if your income reduces your purchasing power will decline, or if you buy a primary residence, then your purchasing power will decline. If you buy a primary residence too early it can lead to you not being able to afford a rental property as you have maximised your loan purchasing power with the banks. As we know primary residence doesn't generate income and is a liability in the sense that we have to repay the loan from our pocket. 

Remember that it's always quicker to sell a property to increase purchasing power than to increase your income to be able to buy more. Often in property investing, deals are not assessed over months, sometimes it happens as the opportunity arises, which could be a few days. Ensure you have enough purchasing power to make your property investment to not lose out on the deal. 

Summary

Use this knowledge gained to reassess your current property position. Ensure you have sufficient purchasing power to capitalise on the next property deal, to build your portfolio to financial independence.

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